Approaches to Creating Value

[Craig Haskell]

This is from a chapter in the book, [removed] Thought some of you might find it of some value:

Creating value can be as simple as buying a property that’s in great condition and in a great location in a rebounding and growing community. But, creating value can also demand very specialized expertise and knowledge, like buying an underutilized property and re-developing the property into another completely different use. Over the last century, the most used approaches to creating value have been somewhere in middle, where some expertise is required.
In this chapter, we will look at two approaches to creating value that require different levels of expertise and investment horizons.

The first approach is “forced appreciation opportunities†where value investors actively engage in strategies to create value in the short term. Investors search for investment opportunities where they can use their expertise and knowledge to force value creation through hands-on activities.

The second approach is “emerging growth opportunities†where value investors uncover external economic or market activities that are expected to lead to growing opportunities in the long term. Both approaches involve the process of value creation on investments, whether over the short term or long term.

Forced Appreciation Opportunities

Real estate value investors that use the forced appreciation approach like to take control of their investments, not waiting for outside occurrences to happen. The old saying, “If it’s to be, it’s up to me,†is a hands-on approach many investors use to create their own appreciation. These types of investors can create large returns through their expertise, hard work, market intelligence, shrewd observations, relationships and unique strategies.
Back in the early 90’s, I bought a tired 20-unit apartment building in Phoenix from an inexperienced investor. I bought the property well below the market value in a short sale with the seller and his lender. I gave the property a nice swift kick in the butt with new management and some renovations, raised the rents over a four year period and sold a turn-key, fully occupied property to another investor for a nice profit. My investors and I made 10 times our investment in four short years.
Looking back now, it’s easy to see the great profit potential. But, what’s hard to see is all the hard work and hassles that accompanied this property. Was it worth it? Heck yes. Without my effort and hands-on work, the profit may never have happened. Most forced appreciation deals can be quite active and hands-on.

All Properties are Not Fixers

There are many ways to create value through forced appreciation that do not involve fixing properties. Generally, most people believe that to create value you need to get dirty by renovating properties. Not true. Savvy real estate investors that have good negotiating skills, combined with being at the right place at the right time, can buy properties or notes at significant discounts, especially in today’s real estate environment.
For example, real estate value investor, The Magellan Group, purchased a $45M note for $32.2M, a 28.4% discount on a 100% leased, 531,000 sq. ft. industrial building. Current as-is appraisal is $49,500,000, creating a significant value creation for The Magellan Group and a very safe loan for Mesa West Capital.
Properties are available to buy with value creation opportunities that are in great condition. With the distressed debt market, many top properties have been subjected to mortgage defaults. Shrewd investors either buy the notes at a discount or buy the property through a short sale.

Research Leads to Making Great Deals

All value creation opportunities are based on the foundation of research. Good ideas are supported by research. Medical breakthroughs are founded on good research. Technological advances are based on research. Research is the very essence to finding and proving value creation opportunities are viable. Without studying and researching, value investors are stuck with guesswork, speculation, and hunches that may lead to poor investments. It’s like buying your home over the internet without ever seeing it - simply baseless.
It’s amazing the number of investors that buy real estate without researching their investments. Peter Lynch, the superstar money manager, said, “Know what you’re investing in and why.†To find the answer to WHY you are investing in a deal, you need to investigate and research your reasoning.
Value investors that invest in niche tenant bases need to research to find the best tenant base to target. Value investors that are planning to reposition a property need to research to find out who they’re repositioning it to. Ivan Boesky said in the Wall Street Journal back in 1987, "My advice to investors is the same that I give to young investors in my classes. Devote the same earnest attention to investing that $50,000 as you devoted to earning it."

Entrepreneurial and Enterprising Spirit

Forced appreciation opportunities require entrepreneurial foresight when buying real estate deals to plan and budget the value creation. First, an investor needs to see the value potential a property might contain. Many times, the real key to being a real estate value investor is seeing value or missed opportunities that others don’t see.
Are there things you can add to a property that will increase rents? Does the property need better management? Is the property serving the highest and best use tenant profile to get the highest rents? Can you re-design space to generate more revenues? Are there services, features or amenities that you can add to generate higher revenues?
Once you’ve found ways to create value, next you must create a well thought out business plan that lays out your value creation vision. The essence of your plan should very pointedly spell out how you are going to create value and make money with the property. This plan will be used to execute your plan, as well as help you raise debt and equity funds.
Finally, you will need to sell your plan to potential stakeholders. If you have found a rock solid deal with lots of value creation opportunities, getting buy-in from potential partners will be easy. But in the end, the ability to see value in a deal and be able to communicate the value you see will be critical. Let your entrepreneurial and enterprising spirit shine.
I raised $10 million from one investment fund to partner with me to buy a three property portfolio of multifamily properties in the Phoenix area. The value creation opportunity was to reposition the assets toward the Hispanic theme tenant base. I presented a detailed business plan that clearly supported the underserved niche opportunity to my investor. When we met in Phoenix to see the properties, I was able to factually communicate the value creation opportunity. We eventually partnered to buy the properties. Be entrepreneurial with your thinking. Find better ways to do things that create value, and the support from stakeholders will be there for you.

Emerging Growth Opportunities

Jim Cramer of “Mad Money†says, “There is always a bull market somewhere.†Even when the stock market is in a bear market and going down, Jim Cramer finds buying opportunities in stocks that are in a bull market going up. The real estate market is made up of smaller submarkets located throughout the world. Real estate prices may be going down in Las Vegas, Nevada, but they’re going up in Sydney, Australia. There is always somewhere to find emerging growth opportunities to create value.
Earlier, we were talking about the importance of research. The only way you’re going to find emerging growth opportunities is through research. Emerging growth opportunities aren’t yelling out saying, “Over here!†Part of your research should include watching the big whale investors. What are they doing and why? At the very minimum, find out what they’re doing so that it gives you something to research to confirm their strategy. [REMOVED]

Search For Undervalued Communities

Can you uncover the next Orange County California? Until 1950, Orange County was a heavy agricultural area with acres of orange trees and strawberry fields. By the mid-1950s, Orange County’s farms were being replaced by tract housing faster than any other community in the United States. Existing cities began annexing territory in every direction, and new cities incorporated almost every year. Between 1953 and 1962, Buena Park, Costa Mesa, La Palma, Garden Grove, Cypress, Westminster, Fountain Valley, Los Alamitos, San Juan Capistrano, and Villa Park all voted to incorporate. In 1963, the county population topped one million. Tourism, manufacturing, and the service industry began to dominate the local economy. The opening of Disneyland in 1955 made Orange County an international tourist destination. By 1980, the population had doubled in size to over 2 million people in just 20 years time. This undervalued community became a real estate bonanza for investors.
There are many undervalued communities around the world where real estate value investors can find emerging growth opportunities. Could Brazil be the next Orange County? Bloomberg wrote about Sam Zell, famous value investor, in a May, 2010 article, “Zell’s Firm Raising $500 Million for Brazil Propertyâ€:

“Billionaire investor Sam Zell’s Equity International is seeking to raise about $500 million to step up investment in Brazilian real estate, betting interest rate increases will fail to stem demand as the economy grows at the fastest pace in two decades. The firm will invest as much as two-thirds of the money in Brazilian companies tied to the residential and commercial property industries and the rest in other countries outside the U.S.,†Chief Executive Officer, Gary Garrabrant said. The new funds will bring the Chicago-based company’s total invested capital to about $2 billion.
“Our enthusiasm for Brazil could not be higher,†Garrabrant, who co-founded Equity International with Zell in 1999, said in a May 18 interview in Sao Paulo. “You’ve got this local demand that’s unparalleled.â€
“Rising incomes among Brazil’s burgeoning middle class will ensure that a cycle of rate increases won’t suppress housing demand,†Garrabrant, 53, said. The economy will grow 6.3 percent this year, according to a central bank survey published this week. Brazilians’ average monthly income has risen close to 40 percent in the past five years 1,400 reais, according to the census bureau.

You don’t need to fly across the world to find emerging market opportunities; they’re right in your back yard. Research your local market and look for the following clues:

• What part of town has the highest job growth?
• What part of town is experiencing well above average population growth?
• Speak with local realtors to find out popular spots.
• Are there any new industries emerging with expected growth?
• Where are the best schools?
• Is government growing anywhere?

Discovering Rebounding Growth Markets

Many high flying, high growth markets tend to have more severe real estate boom and bust cycles. Markets like Las Vegas, Phoenix, Atlanta and others tend to experience rapid growth from high population and job growth, causing real estate construction to overbuild and create a glut of space. This leads to a bust in the real estate market leading to foreclosures and severe pricing reductions. As these markets begin to gain strength from supply of empty space being absorbed, job growth and population growth will again propel these markets.
Real estate value investors are presented with inefficient markets when the prices drop below rising strong fundamentals.

Find Inefficient Markets

Market forces drive real estate prices higher or lower than intrinsic values. Emerging growth opportunities exist by researching and understanding mispriced real estate because of inefficient market pricing. Inefficiency means that certain players continue to have preferred access to information and expertise that allow them to capitalize upon these inefficiencies.
Everything boils down to supply and demand dynamics. Where can you find expected demand real estate needs? If supply for the demand is low, then an inefficient market exists because real estate prices are undervalued.

We Are Value Creators

Here’s how I want you to look at yourself. You are a value creator. Your sole focus as a real estate value investor is to hunt down, uncover and find value creation opportunities for you and your investors. Find opportunities where you can use one of many strategies to create value on your real estate investments.
As Warren Buffet said, “Rule No. 1 is to not lose money.†Find properties that offer a margin of safety, properties where you can purchase them below their intrinsic value to create a margin of safety so that you don’t violate Rule No. 1. Once you find an undervalued property, conduct thorough research that supports and proves that you have found a value investment. Then, execute a value creation strategy with your investment that generates attractive returns.
In the next chapter, we will talk about strategies you can use to create value.